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IMF Survey: Poor Countries Need Extra Help to Get Through Global Crisis

By Maureen BurkeIMF Survey Online

March 5, 2009

Low-income countries will be hit hard by global economic crisis

More financial support is needed to help countries preserve priority spending

Without action, sharp rise in poverty, increased political instability could result

Bredenkamp: low-income countries had no role in the problems that have tipped the economy into recession, yet they are the most vulnerable to its effects (photo: IMF)

A new IMF study finds that at least $25 billion in urgent concessional financing will be needed this year to help low-income countries affected by the deepening global economic crisis and prevent millions from falling back into poverty.

Market in Port-au-Prince, Haiti, one of several countries the IMF names as particularly vulnerable to the effects of the crisis (photo: AFP Photo/Thony Belizaire)

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“The majority of low-income countries will find it difficult to preserve priority expenditures that protect the vulnerable groups without increased external assistance,” said Hugh Bredenkamp, one of the study's authors. “For those countries, it’s particularly important that the donors scale up aid.” Advanced countries had pledged to double aid to Africa, which is particularly vulnerable, but so far the increase has fallen well short of this commitment.

In the following interview, Bredenkamp, Deputy Director of the IMF’s Strategy, Policy, and Review Department, discusses why low-income countries were drawn into the crisis, what risks lie ahead, and how the international community can help.

IMF Survey online: Low-income countries were not initially affected much by the financial crisis, given their low level of integration with the international financial markets. How did the crisis catch up with them?

Bredenkamp: The initial impact through the financial sector channels was indeed more limited in low-income countries than it was elsewhere. But low-income countries have become much more integrated with the rest of the world through trade, foreign direct investment, and remittances than they were at the time of the last major downturn in the early 1990s.

So, as the global recession began in late 2008, we started to see the impact on low-income economies. Remittances are declining, export growth is slowing down, foreign direct investment is expected to shrink this year by 20 percent, and commodity prices—which are important for many low-income countries—have slumped, reflecting the slowdown in global demand. This has actually benefited some net importers of fuel and food that were previously hit by high commodity prices, but it’s also hurt the commodity exporters—countries like Mongolia and Zambia.

IMF Survey online: The crisis is straining budgets in many low-income countries, with lower revenues and potentially lower donor support on the one hand and greater social spending needs on the other. How should policymakers respond?

Bredenkamp: It depends on the country’s individual circumstances. During the good times, some low-income countries were able to build up a buffer—either by accumulating reserves (especially the big commodity exporters) or by reducing their debt levels. These countries now have fiscal space to protect high-priority expenditures on health, education, and infrastructure. For countries that have the ability to do it, that’s what we would recommend.

But the majority of low-income countries will find it difficult to preserve these critical expenditures, including safety net measure that protect the vulnerable groups, without increased external assistance. For those countries, it’s particularly important that the donors scale up aid.

Bredenkamp: Ghana and Sri Lanka are good examples of the relatively few low-income countries that, prior to the crisis, had begun to get access to international financial markets to help finance their budgets. They were both hit as the markets essentially shut down. Ghana had plans to issue a big euro bond last autumn, but had to put them on hold, and Sri Lanka has seen the spreads on its international borrowing rise to essentially prohibitive levels. At the same time, these countries have seen foreign investors exiting from their domestic bond markets. So those two avenues for financing budgets are now drying up.

These frontier emerging market economies have also suffered from some of the same effects as other, less advanced low-income countries. Remittances, for example, are a huge income flow for Ghana, roughly equivalent to 30 percent of their exports. We’re projecting that Ghana’s remittances could drop by about 20 percent this year. So the frontier emerging markets have suffered from a mixture of the more advanced kinds of shocks and the more traditional forms.

Bredenkamp: low-income countries had no role in the problems that have tipped the economy into recession, yet they are the most vulnerable to its effects (photo: IMF)

IMF Survey online:What has been the impact of the crisis so far on banks and other financial institutions?

Bredenkamp: This is an area where low-income countries are, relatively speaking, in a fortunate position compared to more developed economies. They have very limited derivatives markets and interbank markets, and their banks typically fund their lending more through local deposits than through foreign borrowing. Their banks have been relatively profitable, because banking systems in low-income countries are less competitive than those in the advanced economies. That profitability has led to relatively high levels of liquidity.

So their financial systems have not seen major stresses thus far, but there are certainly risks. Many low-income countries have a high share of foreign ownership in their banking systems. To the extent that parent banks become capital constrained, there is a risk that they will withdraw capital from subsidiaries in developing countries.

And we’ll see more and more borrowers from banks in developing countries get into difficulty servicing their debts as the recession takes its toll, just as we’ve begun to see in advanced economies. As those difficulties mount, the balance sheets of the banks will deteriorate, and this could also pose a risk.

IMF Survey online: A number of low-income countries, particularly in Africa, have recently benefited from debt forgiveness. Is there a high risk of reemergence of debt in low-income countries?

Bredenkamp: Debt relief has indeed reduced the debt levels for many low-income countries. The IMF alone has contributed around $6 billion to debt reduction for 24 low-income countries to date under the HIPC and the MDRI initiatives.

The global crisis will worsen the debt situation of many countries—both because of the increased borrowing that the countries will have to do to get themselves through the recession, but also because their export and tax revenues will be reduced. So they’ll get hit on both sides.

The extent of the threat here depends critically on the response of the donor community. If the additional borrowing needs that these countries face are matched by highly concessional aid from donors—either grants or very low-interest loans—then the impact on the debt situation could be manageable. But it also depends on how the crisis evolves. If it turns out to be more severe than we’re currently projecting, the implications for debt could be worse. The countries themselves also need to do their part, of course, by maintaining prudent borrowing policies.

IMF Survey online: Why is the IMF seeking to double the size of its trust fund for concessional lending?

Bredenkamp: The Fund’s capacity to make concessional loans—that is, highly subsidized resources—to our lowest-income members has been dwindling steadily in relation to the growing size of economies and levels of trade, just as our overall conventional resources have not kept pace with the expanding global economy. Our contribution to low-income countries’ financing needs has fallen to less than half what it was a decade ago. This did not surface as a problem in recent years because low-income countries had been doing relatively well and there was a lot of liquidity that provided alternative sources of financing.

Now, as we see those alternative sources of financing dry up and the economic situation deteriorate, it has become clear that the Fund’s resources are inadequate. We have done country-by-country projections, and these suggest that the needs for IMF concessional financing will be roughly double what our current resources could sustain—not just for the duration of the recession, but over the medium term.

IMF Survey online: There are signs of increased protectionism in the advanced economies—as well as in the low-income countries themselves. How big a threat is this to low-income countries?

Bredenkamp: Protectionism can hurt all economies, from the most advanced to the least. So far there have been only isolated examples of this, but it’s enough to set off alarm bells. There have been messages from the IMF Managing Director, the World Trade Organization, and leaders around the world exhorting each other not to resort to protectionism. As we all know, beggar-thy-neighbor policies aggravated the downturn during the Great Depression. That’s an experience we do not want to repeat.

We will see increased political pressures for protectionism as job losses mount. Politicians need to remind people why this is the wrong way to go to deal with the crisis.

IMF Survey online: The paper projects that low-income countries might need about $25 billion to offset the impact of the shock on their reserves. But the doubling of aid to Africa promised by G-8 leaders at Gleneagles in 2005 has yet to materialize. What can the IMF do to get donors to live up to their pledges?

Bredenkamp: The Fund staff’s main role is to do the analysis and present the facts to the international community on the needs and the outlook. We have done the analysis for low-income countries in the paper just published, and the figure that you mention appears in that paper. The IMF Managing Director has presented the findings of that study, and we will be looking for opportunities to disseminate further the messages and the findings of that paper at the Tanzania conference next week and in the runup to the Spring Meetings in late April of the IMF and the World Bank. Equally important is the role that Fund staff play at the country level, by helping governments make a technically solid and convincing case to donors.

IMF Survey online: In sum, what’s the main message of the IMF’s study?

The impact of the crisis on low-income economies will be as severe, over the medium term, as it is for the advanced and emerging economies, albeit in different ways. It was not a crisis of their making; they had no role in the problems that have tipped the economy into recession. Yet they are the most vulnerable economies, and they need the support of the international community to cope with the fallout.

If that support is not forthcoming, our fear is that many countries will be forced to cut priority expenditures just as they’re going into a recession, which is precisely the opposite of what the IMF would like to see. This could tip more people into poverty and lead to increased political instability in some of these countries where we’ve seen political progress over the last few years, hand-in-hand with economic progress. This outcome would not be in anyone’s interest, and this is the main case for a concerted and convincing international response to the crisis.